Sunday, May 25, 2003

After a week's haitus, Paul Krugman turns in a great opinion piece in Saturday's Times. Titled "Fear of a Quagmire?", Krugman turns our attention away from the circus in Iraq and towards the certainly less exciting but by far more consequential global crisis: global deflation.

Krugman does well in showing us as many are now doing that 21st century deflation is not a monetary phenomenon. Deflation is the symptom, not the disease itself, and monetary policy alone is unlikely to head it off. Mr. Yen tells us deflation is structural, and Krugman chooses to hammer the "liquidity trap" argument, but they are saying similar things.

Krugman asks "what if the economy is in such a deep malaise that pushing interest rates all the way to zero isn't enough to get the economy back to full employment?" For Big K, "deep malaise" is the polite way of saying structural overproduction. That is, who would borrow money to produce goods for non-existent consumers?

Now deflation does not equal deflation spiral. Japan has been in a Jimmy Carteresque "malaise" for some 13 years now, but no deflation spiral has occurred (although Japan is entering its fifth consecutive year of falling prices). In a similar manner, the US could very well sink into "malaise" for years on end, a period far worse than the "jobless recovery" of the early 1990s. In fact, it may be hard to tell the difference between recession and recovery in this new era, as we are certainly seeing today.

Global deflation can be headed off only through global coordination. For all the bravado of G.W. landing on that aircraft carrier and proclaiming "mission accomplished," The Shrub has to realize that you can fight a war alone (especially if you're the United States) but you can't lasso the global economy alone (even if you're the United States). Yah, tell that to Rummy and all the other hormone cases at the Pentagon pumping up on GNC Pro Performance.

Krugman is more sanguine than the General, however, when he emphasizes the ability to plan one's way out of the "liquidity trap" through expert pre-emption. Since deflation is both a structural and a global phenomenon, however, there's little reason to be hopeful.

Krugman wraps up saying, "In short, those of us who worry about a Japanese-style quagmire find the global picture pretty scary. Policymakers are preoccupied with their usual agendas; outside the Fed, none of them seem to understand what may be at stake." Here's a toast we can all agree on.

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